The Redistributive State: How Government Shifts Economic Resources from High- to Low-Income Households

This week, the U.S. Census Bureau will release its annual report on income and income inequality. Historically, the official Census figures on inequality are misleading because they fail to account for most government fiscal redistribution. The high taxes paid by affluent households are ignored, and most of the government benefits and services received by lower-income households are not counted.

But government fiscal redistribution in the U.S. is extensive: the transfer of resources from higher- to lower-income groups is a major governmental activity.

The left constantly complains about inequality, calling for higher taxes and increased government spending. But before calling for even more government redistribution, it is important, at least, to understand how much redistribution currently occurs.

A new report from The Heritage Foundation analyzes total government fiscal redistribution. It follows the Census Bureau framework by ranking all households according to income and then dividing the households into five “quintiles,” each containing one fifth of households. The total federal, state, and local taxes paid and the total government benefits and services received by each quintile are then calculated.

The average household in the top quintile received 31 cents in benefits and services for every $1 in taxes paid.

The lower-income three quintiles (containing 60 percent of households) were found to be in fiscal deficit: they received more in government benefits and services than they pay in taxes.

By contrast, the top two quintiles were in fiscal surplus: they paid more in taxes than they received in government benefits.

The average household in the bottom-income quintile received $6.87 in government benefits and services for every $1 in taxes paid. On average, these households received $24,700 more per year in government benefits and services than they paid in taxes.

By contrast, the average household in the top quintile received 31 cents in benefits and services for every $1 in taxes paid. On average, these households paid $48,000 per year more in taxes than they received in benefits and services. The surplus taxes paid by these households represented around one-sixth of their overall pre-tax income.

In 2004, the top two quintiles paid about $1.3 trillion more in taxes than they received in government benefits. One trillion dollars of these surplus taxes were used to pay for the benefits and services for the individuals in the lower-income half of the population. This transfer of economic resources represented around 8 percent of the gross domestic product.

If a similar ratio of transfers occurred in 2014 (which is likely), then around $1.4 trillion in economic resources was transferred from high- to lower-income households in that year. That would be about $9,000 for every person in the lower-income half of the population.

The government benefits and services accounted for in this analysis included Social Security, Medicare, Medicaid, means-tested welfare benefits and services, unemployment insurance and other cash transfers, and public education. The cost of routine government services such as police and fire protection, roads, and sewers was also included. Public goods such as scientific research, national defense, and interest on government debt were not included. All federal, state, and local taxes were counted, including federal and state income taxes, Social Security contributions, corporate profit taxes, sales and excise taxes, and property taxes.

The main problem with the social welfare system in the U.S. is not a lack of government spending. Instead, the main flaw is that most welfare programs discourage work and actively penalize marriage. This increases dependence and the apparent need for even greater spending, a self-perpetuating cycle with no end in sight.